Chapter 5: Q15-1CP_a (page 500)

Question: The Bailey Corporation, a manufacturer of medical supplies and equipment, is planning to sell its shares to the general public for the first time. The firm’s investment banker, Robert Merrill and Company, is working with Bailey Corporation in determining a number of items. Information on the Bailey Corporation follows:
Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)
$42,680,000
Cost of goods sold
$32,240,000
Gross profit
$10,440,000
Selling and administrative expenses
$4,558,000
Operating profit
$5,882,000
Interest expense
$600,000
Net income before taxes
$5,282,000
Taxes
$2,120,000
Net income
$3,162,000
Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash
$250,000
Marketable securities
$130,000
Accounts receivables
$6,000,000
Inventory
$8,300,000
Total current assets
$14,680,000
Net plant and equipment
$13,970,000
Total assets
$28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable
$3,800,000
Notes payable
$3,550,000
Total current liabilities
$7,350,000
Long-term liabilities
$5,620,000
Total liabilities
$12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at $1 par)
$1,800,000
Capital in excess of par
$6,300,000
Retained earnings
$7,580,000
Total stockholder’s equity
$15,680,000
Total liabilities and stockholder’s equity
$28,650,000
a. Assume that 800,000 new corporate shares will be issued to the general public. What will earnings per share be immediately after the public offering? (Round to two places to the right of the decimal point.) Based on the price-earnings ratio of 12, what will the initial price of the stock be? Use earnings per share after the distribution in the calculation.

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Answer

The earnings per share will be $1.22 and the initial price of the shares will be $14.64.

Step by step solution

Net income = $3,162,000

Shares outstanding = 1,800,000

New shares issued = 800,000 shares

PE ratio = 12 times

The earnings per share after the issue is $1.22.

$Earnings per share = \frac{Earnings}{Number of shares} = \frac{$ 3, 162, 000}{2, 600, 000} = $ 1.22$

The initial price of shares is $14.64.

$Intitial market price = EPS \times PE ratio = $ 1.22 \times 12 = $ 14.64$

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	$28,650,000